V2X Inc (VVX) 2016 Q3 法說會逐字稿

Good day, everyone, and welcome to the Vectrus, Incorporated third-quarter 2016 earnings results conference call. Just a reminder, today's call is being recorded. For opening remarks and introductions, I would now like to turn the conference over to Michael Smith, Director of Investor Relations and Corporate Development. Please go ahead sir.

Thank you, Debbie. Good morning, everyone. Welcome to the Vectrus third-quarter 2016 earnings conference call. Joining us today are Ken Hunzeker, Chief Executive Officer and President; and Matt Klein, Senior Vice President and Chief Financial Officer. Slides for today's presentation are available on our Investor Relations website, investors.vectrus.com. Please turn to slide 2.

During today's presentation, management will be making forward-looking statements pursuant to the Safe Harbor provisions of the federal securities laws. Please review our Safe Harbor statement in our press release for a description of some of the factors that may cause actual results to differ materially from the results contemplated by these forward-looking statements. We assume no obligation to update our forward-looking statements.

Also, we will be making reference to non-GAAP financial measures during this call. We remind you that these non-GAAP financial measures are not a substitute for their comparable GAAP measures. You can find the non-GAAP reconciliations and other disclosures in our earnings release and in our presentation slides which are publicly available on the Vectrus website at investors.vectrus.com. At this time, I would like to turn the call over to Ken Hunzeker.

Thank you, Mike. Good morning everyone. Thank you for joining us on the call. Today we are reporting third-quarter 2016 financial results. Please turn to slide 3. Revenue was $284 million compared to $299 million from last year, mainly driven by the anticipated reduction of our contracts based in Afghanistan. Our operating margin in the third quarter was 3.9%. Diluted earnings per share were $0.60. Year-to-date 2016 net cash provided by operating activities was $34 million. Our days sales outstanding, or DSOs, continue to be favorable and were 55 in the third quarter.

Our strong cash collections enabled us to make voluntary debt payments totaling $8 million in the quarter. The $8 million of voluntary payments -- I'm sorry, year-to-date debt payments to $10 million. In total, we have made $22 million of voluntary debt payments since September 2014, and reduced our total debt by 33%. Please turn to slide 4 where I will provide an operational update on Vectrus.

As previously announced, during the quarter, we were notified that Vectrus was not selected as the Army's provider for the Kuwait-based operations and securities support services contract recompete, or K-BOSSS 2.0. We, along with all three other unsuccessful bidders, protested the award decision to the Government Accountability Office, or GAO. On November 7, 2016, we were notified by the Department of the Army that it was taking corrective action to resolve the protest. As part of the corrective action, the Army will amend the solicitation to clarify its requirement, request revised proposals from the existing offers based upon the amended solicitation, and conduct discussions if necessary, and issue a new award decision.

Through September 30, 2016, K-BOSSS contributed $323 million, or approximately 36% of revenue. Additionally, the K-BOSSS contract currently runs through December 28, 2016, with an option to extend through March 28, 2017. We are pleased with the corrective action and look forward to working with the Army through the process.

Also during the quarter, Vectrus announced we were not selected for the consolidated Army Prepositioned Stocks-5, or APS-5, contract which includes our current APS-5 Kuwait and APS-5 Qatar contracts. We filed the APS-5 protest on September 13, 2016. The GAO has up to 100 days to issue a written decision. Accordingly, we expect the GAO to issue a written decision no later than December 22, 2016, for the APS-5 award protest.

We believe our protest has merit and we will continue to vigorously advocate for our superior proposal. Through September 30, 2016, APS-5 Kuwait contributed $134 million, or approximately 15% of revenue. The current protest on APS-5 contracts makes assessing the future revenue streams somewhat difficult. However, on October 26, 2016, we received a contract modification of $46 million to extend the performance of the APS-5 Kuwait contract. The modification has an estimated completion date of February 28, 2017. Based on current information, we believe it is likely but not guaranteed, that APS-5 Kuwait and K-BOSSS will contribute revenue through the first quarter of 2017.

We recently announced a reduction in force and realignment. Reduction resulted in the elimination of 64 positions at the Vectrus headquarters. Additionally, the realignment will complete the actions we initiated earlier this year by placing critical business functions closer to customers and programs. We will maintain our investment in the business development and other functions that drive revenue. Our investment in the IT network service offerings continues and is not impacted by the aforementioned reductions in force. We have assembled an experienced team that aligns with significant market potential for the Company, and we expect full-year contributions to revenue in 2018.

Regarding new business, we have taken great strides to improve our position. As a matter of fact, we just concluded our 2016 leadership conference where the theme was winning in a competitive environment. We brought in Vectrus leadership from all over the world in order to participate in this event. Everyone at Vectrus understands that retaining existing business and winning new work is our top priority.

The business development reorganization actions taken earlier this year give me great confidence in our ability to win new awards. We currently have $1.5 billion of bids submitted awaiting potential award. Additionally, we plan to submit proposals on over $7 billion of identified opportunities over the next 12 months, all of which are for new business. We have historically not provided timing on expected awards as various factors make this task extremely difficult to predict. However, in order to potentially help provide some visibility, as it stands currently, we expect to hear the results on about $1 billion of bids in the next six to nine months.

Also, after a prolonged protest period, the Danish subsidiary owned by Vectrus is currently in discussions with the Air Force regarding commencement of the Thule base maintenance contract next year. We're looking forward to providing the Air Force customer with an affordable-to-robust solution while adding this new work to our backlog and recognizing the associated revenue. While we are still in discussions with our customer regarding commencement of the contract, we believe any potential revenue streams associated with this contract would be in the second half of 2017.

In October, we announced a joint venture to pursue the US Army's Logistics Civil Augmentation Program 5, or LOGCAP V, contract vehicle. LOGCAP V has an estimated ceiling value of $150 billion and is meant to provide contingency support to augment the Army force structure. From 2007 through 2015, approximately $19 billion has been obligated to three vendors under the LOGCAP IV program. Ordering on LOGCAP IV ends on April 2, 2017, and we will likely receive additional information regarding the expected timing of the award at the industry day next week.

Since late 2014, we have talked numerous times and at length about our three recompetes. The remaining recompete of the three to be awarded is our Maxwell base operations support program. We are currently operating under an option period that extends into November 2016. The Maxwell recompete is a low-priced, technically acceptable, or LPTA, bid.

We have strong past performance on Maxwell and have also proven we can succeed on LPTA procurements. As a matter of fact, our Thule, Turkey, Spain Base Maintenance contracts, in addition to our most recent AFCAP cash quarter win, were awarded on an LPTA basis. We know how to bid lean and we also know how to execute under those requirements. We expect the award on Maxwell to be made in the first quarter of 2017. Outside of Maxwell and looking ahead, given the heavy volume of recompetes we have experienced recently, we expect 2017 to be a much lower year of recompete volume with no one contract making up 5% or more of our 2016 revenue midpoint.

I would like to point out that we've reached the upper end of our previously communicated 2016 voluntary debt payment range of $8 million to $10 million ahead of schedule. We've made great progress in paying down our debt, reducing total debt by 33% since September 2014, and at September 30, 2016, we had total debt of $94 million, representing a 1.76 debt-to-EBITDA leverage ratio.

In April 2016, we amended our credit agreement, which resulted in more favorable covenants. Regardless of how the K-BOSSS 2.0 and APS-5 contracts are resolved, I am confident in our ability to meet our financial obligations. Now I'd like to turn the call over to Matt. He will go through our financial results and provide details regarding our updated 2016 guidance and our current view of 2017, then we will open the call up for questions.

Thank you, Ken. Good morning, everyone. Please turn to slide 5. Today I will be discussing our financial results for the three and nine months ended September 30, 2016. The tables at the top of page 5 and 6 reflect the generally accepted accounting principles, or GAAP, financial results for Vectrus.

The tables at the bottom of page 5 and 6 reflect the adjustments made to operating income and diluted earnings per share in the prior-year period only, which excludes separation costs required to become a stand-alone public company and one-time favorable settlements of past liabilities. I will address the financial results related to income measures on an adjusted basis, which we believe better reflect the ongoing business trends. You can reference the appendix of this presentation for the reconciliation of our adjusted results to GAAP.

For the third quarter, funded orders were $77 million, down $367 million compared to the same period of 2015. This change is primarily driven by a partial-year funding increment on our K-BOSSS contract as this contract approaches the end of its contractual period of performance. In the third quarter, revenue was $284 million, down $15 million, or 5%, compared to the same period of 2015. This change was primarily driven by a $26 million decrease in revenue from Afghanistan programs and a $12 million decrease in revenue from our US and European program, partially offset an increase in revenue from Middle East programs of $23 million when compared to the third quarter of 2015.

Operating income was $11.2 million, or 3.9% operating margin, in the third quarter of 2016, $600,000 or 5% lower compared to the third quarter of 2015 adjusted operating income. The change is primarily driven by the year-over-year decrease in revenue. Diluted earnings per share for the third quarter were $0.60, compared to adjusted diluted earnings per share of $0.65 in the third quarter of 2015. This is primarily driven by the year-over-year decrease in revenue, higher shares outstanding, and offset partially by lower interest expense. Interest expense decreased for the three months ended September 30, 2016, when compared to the three months ended September 25, 2015, due to a lower long-term debt balance.

Please turn to slide 6. Now I'd like to turn your attention to the year-to-date 2016 financial results. Our funded orders were $986 million, an increase of $66 million compared to the same period in 2015, primarily due to timing of funded awards and contract extensions. Year-to-date 2016 revenue was $902 million, an increase of $33 million, or up 3.8% when compared to the same period of 2015. The increase was driven by the growth on our Middle East programs of $108 million, which is partially offset by the decline in revenue from our Afghanistan programs of $52 million, and US and European programs of $23 million.

Operating income was $34.3 million, or 3.8% operating margin year to date in the third quarter of 2016, which is $2.2 million or 100 basis points favorable when compared to the adjusted operating margin for the same period in 2015. This is due to increased revenue and operating margin performance year-to-date 2016. Year-to-date 2016 diluted earnings per share were $1.76, compared to adjusted diluted earnings per share of $1.69 in the third quarter of 2015. This is primarily due to increased revenue and operating income, offset by a slight increase in the tax rate.

Net cash provided by operating activities was $33.5 million year to date, which was an improvement of $23.5 million versus the same period in 2015. We closed out the quarter with 55 days sales outstanding, which is a reflection of our team's focus on billings and collections. For our current mix of contracts, 55 days is superior performance. However, we do not expect to sustain this level as we grow our business and start up new contracts. We believe a more sustainable DSO is in the low 60s.

Please turn to slide 7. From a capital allocation standpoint, our major goal and focus when we first spun off two years ago, was to manage our debt profile, making sure we were below our debt covenants. As you can see by the graph, we have successfully reduced our leverage profile. Over the past two years we have reduced our total debt by $47 million, or 33%. Additionally over this period, for each dollar of mandatory payments, we have made an almost equivalent voluntary payment. In total, we have made $22 million of voluntary payments and $24.5 million of mandatory payments.

So far in 2016, we have voluntarily paid down a total of $10 million of debt in addition to $10.5 million of mandatory payments. As of September 30, 2016, debt was $93.5 million, which represents a debt-to-trailing 12-month consolidated EBITDA leverage ratio of 1.76 times. We are tracking well below our covenant level of 3.25 times in 2016. In 2017, our debt-to-trailing 12-month consolidated EBITDA leverage ratio covenant level drops to 3 times and reduces to 2.75 times in 2018. Until we get more certainty around future revenue streams from APS-5 and K-BOSSS, debt management will continue to be a focus as we manage the leverage ratios below the levels outlined in the credit agreement.

Please turn to slide 8. For the third quarter, total backlog was $2.1 billion. Total backlog represents firm orders and potential options on multi-year contracts and includes both funded and unfunded contract values. Total backlog exclude the ceiling values of IDIQ contract vehicle awards. Our funded backlog for the third quarter was $768 million. Our total backlog levels have declined year over year, which is a reflection of shorter increments on contract values associated with APS-5 and K-BOSSS as they approach the end of their contractual periods of performance. Importantly, once we receive the notice to proceed on the Thule Base Maintenance contract from the Air Force, we will add this contract to backlog.

Please turn to slide 9. Turning to 2016 guidance, we narrowed the range for revenue to $1.19 billion to $1.2 billion from $1.18 billion to $1.2 billion. The new midpoint for 2016 revenue is $1.195 billion. We are tightening the range for operating margin at 3.6% to 3.8%. As a result, the new midpoint for operating margin is 3.7%. The operating margin range now assumes a severance charge in the fourth quarter resulting from the actions announced on October 18. We expect to record severance of approximately $2 million in the fourth quarter, with the majority charged to SG&A. We anticipate a portion of the severance expenditures to be recoverable, following the rules highlighted in the federal acquisition regulation. Overall, we anticipate the net charge to the income statement to be around $500,000 which is included in our full-year guidance.

We changed the estimated range for diluted earnings per share to $2.12 to $2.28. The midpoint for diluted earnings per share is maintained at $2.20 due to higher net income associated with the increase in the revenue midpoint. Net cash provided by operating activities will range from $30 million to $34 million, with a midpoint of $32 million. Depreciation and amortization is expected to be $2 million in 2016. Interest expense is forecasted at $5.8 million and we currently estimate a 36% tax rate for the full year.

Before turning the call over for questions, I would like to discuss some important elements related to 2017. The outcome of K-BOSSS and APS-5 will likely have top-line considerations in 2017. At this time, we do not have complete information on 2017, but we do have some important elements on each contract that may give insight into next year.

First, related to K-BOSSS, we are on contract to provide full performance through December 28, 2016, with an option to extend through March 28, 2017. Earlier, Ken discussed the Army's notice of corrective action. In light of that development, it seems more likely, although not a guarantee, to see the government exercise the option to extend through March or beyond.

Second, related to APS-5, we are on-contract to provide full performance through February 28, 2017. We also know that the GAO's written decision is due by December 22, 2016, and the APS-5 solicitation has three months transition plan. It would not be unreasonable, although not a guarantee, to see the extension beyond our current performance period. With the scenarios described above, revenue on K-BOSSS and APS-5 contracts may continue through March of 2017.

Thule is expected to contribute no more than a half of year revenue in 2017. As a reminder, the original award is expected to contribute approximately $60 million of annualized revenue. We expect to experience a continued decline in Afghanistan revenue of approximately $40 million year over year.

As discussed previously, we implemented a reduction in force at the Vectrus headquarters. The annualized savings associated with the 64 personnel actions taken in October is approximately $8 million. The cost-savings initiatives will be partially offset by continued investment in our business development team. We believe the actions we have taken to maintain a competitive SG&A without impacting performance or our ability to win future contracts.

As we've discussed in prior conference calls, an element to improve our long-term margin profile was the expectation that recompete contracts would have more contractual levers, mainly fixed-price elements, which would allow us to exercise our continuous improvement program in order to increase margins over time. The outcome of APS-5 and K-BOSSS 2.0 will be essential in gaining clarity around profit margins in 2017.

Full-year net cash provided by operating activities is expected to be slightly above 100% net income conversion. The net working capital position on both APS-5 and K-BOSSS is currently close to zero. Therefore, we do not anticipate a positive cash benefit in those programs if those programs conclude. Mandatory debt payments per the credit agreement in 2017 are $16 million. We will provide more information related to 2017 during our fourth quarter, full-year conference call in March. Now I'd like to turn the call over for questions.

(Operator Instructions)

Brian Ruttenbur with Drexel Hamilton.

Thank you very much. A couple questions, on the backlog first of all, at $2.1 billion from $2.3 billion last quarter, was that all because of K-BOSSS dropping? I know you mentioned something about funded dropping $77 million from K-BOSSS, but could you elaborate a little bit?

Sure. So the $2.3 billion that we realized in the second quarter, as we earn revenue, that comes down with that earned revenue and then any contract value that we see in the quarter adds to that. So the simple math is $2.3 billion in the second quarter, $284 million of revenue in this quarter and then we had about $50 million of additional contract value added to the third quarter. And that contract value comes from AFCAP, about $20 million of our AFCAP cash quarter win in additional work on several of our contracts.

Thank you very much; that's helpful. And then, just as a follow on, Maxwell Air Force Base LPTA, is that what it's always been or under your previous or the current contracts, said better, was it an LPTA contract?

This is Ken. Obviously, it was full and open in the past and not -- it was not our best value. If you look at the buying behavior of the Air Force Education Training Command base in San Antonio, they have been going to the LPTA construct on all their base operations. So, on all the work that's associated with that, it's done on the LPTA basis.

Brian, I would also highlight that our Thule contract and our Turkey/Spain contracts are Air Force contracts, both LPTA; so we have experience, recent experience, with winning with this customer and this contract type.

And then last question, just on K-BOSSS, you were very confident in the past on winning it. Given that there is a brand new chance for you guys in a rebid, do you feel as confident as you were before say six months ago? What do you feel about the chances of rebidding on this contract?

Brian, I got to tell you that our past performance here as we've talked about is exceptional. It continues to be our best value. I think we really don't know exactly what the competition [mission] will look like until we actually see what the government comes back with.

But what I do know is that we will take advantage of all the things that we have done in the past as far as operational excellence, bidding lean understanding the customer's requirements and things along those lines. Based on an understanding the mission, as well as anybody can, I know we will put in a phenomenal solution for this thing and I'm very confident that and hopefully we can win this going forward. Have anything to add?

And what we're looking for in all solicitation is a fair valuation. We found some anomalies that we were concerned about and we raised that to the GAO. The procuring agency agreed and agreed to amend some of the requirements. So we feel like that is the best outcome and, given a fair solicitation, our solutions will be valued and will be competitive.

Thank you.

(Operator Instructions)

Bill Loomis with Stifel.

Thank you good morning. Just on the cash flow guidance, just to be clear, you said 100% cash from operations after working capital will be about 100% net income in 2017; is that accurate?

Right. Typically in this business, we've always said that we track to 100% conversion. There are some non-cash items, like equity grants, that we should see some additional cash. But we wanted to make sure was understood is APS-5 and K-BOSSS are very efficient today. And if they continue through the end of the year, we wouldn't expect any benefit next year if these programs conclude.

Okay. So just the cash conversion this year, at least on the upper end, cash guidance is about 130%. But what is going to change next year; are you just being conservative with 100%?

What we realize this year, is really some inefficiencies that we had in historical periods. We created a VIP, which is a Vectrus Improvement Project, our team is focused on what we could do to improve our accrued receivables and our turns once we submit an invoice. And, as you've seen in our DSOs, the last couple quarters we've been highly successful and couldn't be happier and want to thank our teams for their success.

But with that performance, that's a one-time uptick. So you get efficient on your balance sheet. You realize that this year we are happy to have that cash infusion. You can see we've paid down our debt in advance, so we are at $10 million of voluntary payments. Also if you look at the balance sheet, we have about $50 million, $53 million of cash in our bank account. So we are performing optimally right now, but we can expect that to continue into 2017 because we've already realized that efficiency this year.

And then after you've spent a lot of time I'm sure looking at cost scenarios over the last couple of months. What do you think if let's say you're unsuccessful on the second time on K-BOSSS and then on the APS-5 protest and they completely go away? What kind of cost structure should we be thinking about in that type of scenario?

Can SG&A drop by the revenue amount? Or is it going to be detrimental to margins? Are there some cost savings or the gross margin on those programs being lower that can result in the same or maybe a little better margins if the remaining programs are higher gross margin?

Let me start with our view on cost. We took the first step in considering our SG&A position as we go into next year. What we've always said is we proactively look at our cost structure. We can adapt very quickly. I think our actions on October 18 reflect that.

We also have to be cognizant that we can't impair our ability to bid new contracts. We're making sure that our investment in DD is strong and it is sustained.

The other thing that we think about is we're still performing on APS and K-BOSSS. We're on contract on APS through February and K-BOSSS through December. Some personnel and some cost requirements that's built into our SG&A is required to run those programs. So, my point being is, we've made some adjustments, we expect those adjustments to save about $8 million annualized.

And then, as we know more, as we close out the fourth quarter and if things change, we think we can make some other adjustments and other considerations, but we have to be cognizant. And really, our culture is we have to make sure we perform. We can't sacrifice our performance in managing our cost.

Going back to your questions on margins, I believe that we have enough levers that we can adjust our cost structure, that we shouldn't see a significant margin erosion related to SG&A. As far as setting a specific SG&A targets, we just -- there's too many variables that are in play that I just, I can't commit to right now.

When you say no margin degradation are you talking about if those two programs go away from you that you would be able to hold margins? Is that what you're saying?

Our anticipation, we are in business to make money and increase shareholder value. We would take the appropriate steps and I'm not saying it's pro rata to manage our SG&A to make sure that we're competitive without sacrificing our business development investments, but also trying to maintain margins.

I still believe this Company should be able to realize full percent normalized margins. We're not quite there; we were close this quarter. We were counting on certain levers like the re-compete contracts, re-awarding, having some contractual elements to fixed-price elements that we could implement VIPS program, and realize improved margins over time.

Because this is delayed, the real question is when? When can we realize some increased margin? So we will just have to wait and see. We're happy that we are having a fair solicitation on K-BOSSS. If we can rewin that, then that gives us some more options.

Okay, and then just one quick one. Just talking about margins being good in the third quarter. It looks like you had some good nice positive EAC adjustments. Or those one-time or do you think you could see some more of those over the next year of that type magnitude?

There's always the possibility that we can realize that in the future. The one thing I would caution if you've watch our two months of catch-up in the 10-Q, those changes, those net changes can be positive and negative. There's a lot of factors that go into why they are positive and negative. A lot of it is timing of when you realize cost and when you realize extensions.

This quarter we had a positive catch-up of $1.1 million that contributed to our performance. As we look to the fourth quarter, you notice we tightened our margin range. We are not expecting that kind of an uptick in the fourth quarter although we still have a couple, two more months to close out, so we'll have to wait and see. And if we do, we'd be happy to report them.

Thank you.

Thanks Bill.

(Operator Instructions)

With no other questions at this time, I'll turn the conference Ken Hunzeker for closing remarks.

Thank you for joining us on the call today. Vectrus has a strong reputation of supporting its customers' missions with a legacy dating back to 1945. We've had our fair share of obstacles over the years and in each situation we've found ways to overcome these challenges. Looking forward, we will continue to support our customers' missions with exceptional value, performance and the ethical standards that have come to be expected from Vectrus.

Finally on November 11, 2017, we observe Veterans Day. It's a national day of remembrance honoring the men and women who have served and are serving in the defense of our country. On behalf of the entire Vectrus work force, I would like to thank each veteran for your sacrifices and your service to our great nation. For those service members currently keeping the world safe, thank you for your continued commitment to this great country.

Ladies and gentlemen, thank you for your participation. This does conclude today's conference. You may now disconnect.